Insolvency/litigation: Director’s duties and when not to make a claim

Background

Pro4Sport Limited (“the Company”) was incorporated in 2007 and traded as a supplier of high end sportswear and equipment, mostly by way of internet sales. Mr Adams was a director and the majority shareholder of the Company and also of Pro4Sport.co.uk Limited (“Pro4Sport.co.uk”). The Company made nominal profits in its first three years of trading.

At the beginning of 2012 key suppliers reduced their credit facility, which had a dramatic effect on cash flow. Ebay and Paypal suspended the Company’s account which further exacerbated the problem.

Key Facts

In May 2012 Mr Adams consulted BCIA Limited (“BCIA”) a firm of business advisers about the financial state of the Company. BCIA advised that some form of insolvency was inevitable and advised Mr Adams of his options, which included a sale of the assets by the Company to Pro4Sport.co.uk, a sale by the liquidator of the business as a going concern and a sale by the liquidator at auction. BCIA advised Mr Adams to obtain a valuation of the assets and he instructed them to obtain it on his behalf.

The valuation was as follows:

Reinstatement Cost - £64,000

Open Market Value - £24,000

Open Market Value (in situ) - £37,000

Restricted Realisation - £17,000

The bulk of the assets were stock, which were potentially subject to retention of title claims. The valuation also opined that “the maximum likely consideration for goodwill would be £15,000”. For his part HHJ Behrens found that the goodwill figure was likely to have been in the region of £5,000.

On 25 June 2012 the Company sold its assets to Pro4Sport.co.uk for £47,000 plus VAT by way of an invoice that Mr Adams said was drafted by BCIA. Mr Adams said that he considered that the sale was in the best interests of the Company and its creditors as it avoided costs of sale and the liquidator would have sold the goods at auction, therefore receiving a much lower price. It was agreed that the consideration would be deferred over 10 months with monthly payments of £5,640. Mr Adams was aware that Pro4Sport.co.uk could not pay the sum immediately, but believed it would be able to over time as its major suppliers had agreed to continue to extend credit.

On 20 July 2012 Mr Hedger was appointed liquidator of the Company. It was not disputed that the liquidator adopted the contract. In August 2012 the liquidator sought advice from a valuer as to the price agreed, and was told “the price paid was a fair representation of the value of the assets.”

Pro4Sport.co.uk paid 6 instalments under the agreement but in early 2013 found itself in cash flow difficulties and only made intermittent payments totalling £2,250 after February 2013. In total the liquidator was paid £35,910, leaving £20,490 outstanding.

Judgment

As the Company was insolvent in June 2012 there was also a duty owed to the creditors – Re HLC Environmental Projects Ltd (in liquidation) [2013] EWHC 2876 (Ch). The liquidator argued that Mr Adams:

put Pro4Sport.co.uk interests first in entering into the contract;

the contract was not the best deal for the Company as the sale price was not the best price available to the Company; and

the deferred consideration was a high risk strategy which was not in the best interests of the Company’s creditors.

HHJ Behrens did not accept those submissions. He found that Mr Adams had considered the creditors’ interests and that he believed the contract was in their best interests. Mr Adams did not have to pay the maximum figure specified for the assets and was entitled to take into account that the liquidator may not be able to sell on a going concern basis and to rely on advice. On the deferred consideration Mr Adams had to consider whether such a sale was better than no sale at all and the judge found that he honestly believed that was the case. Accordingly the claim under Section 172 failed.

Section 174

The liquidator argued the three points outlined above were equally applicable and further argued that Mr Adams should have given a personal guarantee to compensate for the consideration being deferred.

The judge found that whilst the terms could have been more favourable to the Company, that did not mean that Mr Adams was not exercising reasonable skill and care. The price agreed, £47,000, was less than the open market valuation in situ plus the maximum figure for goodwill of £52,000, but more than the open market value of the assets, £24,000. Mr Adams was entitled to consider whether the liquidator could achieve a going concern sale and also to take into account that the liquidator would incur costs of sale. Pro4Sport.co.uk could not pay immediately so deferred consideration carried a risk. The question of a guarantee was redolent of hindsight and it was to be noted that the liquidator did not seek one at the time. Mr Adams also relied on the professional advice of BCIA which the judge considered “an important factor in determining if he was in breach of his duty to exercise reasonable care.” The judge found that Mr Adams was not in breach of Section 174.

Section 190

The judge held that this claim had not been properly pleaded and did not consider it “proportionate to deal with the claim” under this section.

The judge concluded that even if Mr Adams had breached his duties, he would have granted him relief under Section 1157 CA 2006. He held that Mr Adams had acted both honestly and reasonably in entering into the transaction. He had acted on advice and the liquidator had not objected to the transaction at the time or when he had been appointed, but had adopted the transaction and agreed the payment schedule.

Finally HHJ Behrens addressed the question of loss on the part of the liquidator. His assessment of what the liquidator might have received if the transaction had not taken place was £32,400 and as the liquidator had received more than this sum, his loss was nil.

Conclusion

This case is an interesting consideration of directors’ duties when insolvency looms and shows that the courts look kindly on those that take and follow reasonable professional advice in this situation. It is also an object lesson in the sort of claim that should not be pursued by insolvency practitioners.

Please contact [javascript protected email address] for more information on this subject, or to ask a question.